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Heavy Profit Taking In Gold Has Investors Licking Their Wounds

Gold has taken a beating since early October, falling more than $100 to lows not seen in more than three months. The yellow metal has suffered from a combination of intense profit taking, technical selling, and an improved stock market, which has zapped capital ahead of a possible fiscal cliff deal. Continued Fed easing should put a floor under prices, but bullion is already looking oversold, presenting a risky opportunity.

Wednesday saw gold traders licking their wounds after a violent “assault” hit them a day before, as investor and market commentator Dennis Gartman put it. Gold prices fell nearly 2% to a 15-week low of $1,662 on Tuesday, continuing a dangerous trend that has called into question gold’s prospects next year. By 12:19 PM in New York on Wednesday, physical gold was trading flat at $1,670.50 an ounce.

“Heavy profit taking” and “book squaring” appear to be the main causes of the sell-off that has endured in the gold market since early October, VTB Capital’s Andrey Kryuchenkov explained. With the year coming to an end, gold investors have been liquidating positions and taking profits ahead of what could be higher taxes, RBC Capital Markets’ George Gero added. Kryuchenkov highlighted long closures in ETF position, little support at lows, and continued technical selling.

Part of the reason is improvement in the fiscal cliff negotiations. After House Speaker John Boehner’s latest proposal, which included tax hikes for those making more than $1 million, and President Obama’s counteroffer, market participants appear increasingly optimistic that policymakers will reach a deal to avoid the full brunt of the fiscal cliff. This, in turn, has sparked a rally in equities: reduced uncertainty and gradually improving economic fundamentals should benefit the private sector, lifting stocks.

This has hurt gold prices, both Gartman and Kryuchenkov said. “Gold hadn’t a chance as capital flees ‘investment’ [in bullion] for real investment in shares,” Gartman noted. “As the macro environment improves, especially provided the ‘fiscal cliff’ is avoided, gold investors in developed economies will increasingly look to diversify from bullion and into riskier assets where returns are better given the ongoing economic recovery and better than expected US data,” complemented Kryuchenkov.

Don’t count gold out going into 2013, though. Fundamentals for the yellow metal look promising, at least in the first half of the year. A weaker dollar “surprisingly” did little to temper the bloodbath on Tuesday, but should prove supportive in the near-term, Kryuchenkov explained. Ben Bernanke’s latest round of quantitative easing, which will see the Fed expand its balance sheet at a rate of $85 billion a month for an extended time frame, will flood the market with liquidity, which should be supportive of gold as well.

Yet risks remain. Three major factors could end gold’s decade-long rally this year. A sustained improvement in U.S. economic conditions which could push up real interest rates, a fading of Europe’s sovereign debt crisis, and a China that’s focused on reforms that will bring lower growth and greater stability threaten gold’s bull run.

While bullion has remained relatively resilient this year, gold equities have provided no safety. Major names in the sector including Newmont Mines, Barrick Gold, and Goldcorp, are all down between 15% and 25% year-to-date, while the GLD gold ETF is up about 4%.

Gold has taken it on the chin over the past few weeks, and the rout could continue. But extremely loose monetary policy should act as a counterbalance, forcing investors to walk the tight rope in making up their minds about the yellow metal next year.

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